Reform Brings Student Loan Relief, But Debt Still Weighs

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. After much debate, Congress has finally delivered a long-awaited deal on student loan rates. Joining me to discuss this and other news in the realm of college funding is Adam Zoll; he is assistant site editor for Morningstar.com.

Zoll: After much debate on Capitol Hill about this issue, they finally struck an agreement which will tie student loan rates moving forward for federal loans to market rates, and what that means for people who are going to be enrolled this coming fall in college is that rather than paying 6.8% on student loans, which would've been the case under the former situation, rates for this coming fall will be 3.86% for undergrads. They'll be 5.4% for grad students and 6.4% for Parent PLUS loans. And what's going to happen moving forward is each year rates will reset based on prevailing market rates, actually tied to the 10-year Treasury note. And those will be fixed rates for the lifetime of the loan, but they will readjust each year, and a key point here is that there are caps on these rates. The rates will never be above 8.25% for undergrads, 9.50% for grad students, and 10.50% for the Parent PLUS loans. That's kind of a key provision.

This is definitely good near-term news for people who are going to be going to school in the fall or in the next few years. However, down on the road, there is definitely the potential that people will be paying rates higher than the 6.8% that had been this fixed rate over the past several years. There is definitely the potential for people to be paying more for loans in the long term than they had been previously.

Benz: One thing that is stunning is really just when you look at the rate of student loan repayment, it's not that good. We're seeing a lot of default rates. Let's talk about what you see when you look at that data on student loan repayment?

Zoll: The Consumer Financial Protection Bureau recently did some research, and it estimates that there is close to $1.2 trillion worth of student debt out there, including about $1 trillion worth of federal student debt. And the number that really jumps out at you is that they estimate that there are more than 7 million student loan borrowers who are in default, and on average those who are in default owe about $14,000, at least among those who are in default in federal student loans.

The impact of being in default on a student loan is pretty severe. You could have your wages garnished, you may not get a tax refund, and obviously it can really wreak havoc on your credit score long term. The student debt crisis that many people have identified and have been talking about is very real for a lot of people. It reinforces the idea that you don't want to over-borrow when you're planning for college costs and more so that whatever you do borrow, you really want to make sure you are repaying that on a regular basis, so that you don't go into default.

Benz: One related news item, Adam, relates to these agencies that help students contend with their debt if it's gotten out of control or they think they may need to consolidate some debts. What do the studies say about the viability of these programs? Should people use one of these agencies or should they try to deal with their student loan on their own?

Zoll: The National Consumer Law Center actually recently issued a report where they looked into these student debt-relief agencies, which are very similar to consumer debt-relief agencies that help people who have credit card debt, for example, manage the debt and pay it off and consolidate it.

Obviously, the student loan market, the student debt market I'll call it, is a huge potential market for these kinds of services, even larger than the credit card debt market. This particular study that was issued by this organization sampled, for example, about a dozen different student debt-relief agencies, and what the study found was that they were really rather inconsistent in terms of the services they provide, in terms of transparency and fees. In some cases, they were charging up to $1,600 in exchange for services that are available from the Federal government for free. And really I would encourage people who are considering using one of these services to first look on the federal government's website at studentaid.ed.gov, which has lots of information about how to manage your student debt and how to consolidate things like that.

The report is critical of the federal government's student debt information. The report says that the system is too complex, and it may make sense in some cases for people to turn to one of these debt-relief services for some help. If you feel like you're willing to pay money to have somebody help navigate the system, it may be worth your while. However, you really need to be careful about the fees you are being charged by making sure you understand what they are and that they don't seem to high or unreasonable. For example, some of the services charge ongoing monthly fees for a loan consolidation, which should be a one-time event.

You really have to do your due diligence and sort of have your own personal radar working to see if it seems like what you're paying money for is worth it.

Benz: One other news item, Adam, recently is the Sallie Mae study that is released periodically, that looks at how people actually pay for school. Loans are obviously a big part of it for many families. What are the other means that families use to pay for college these days?

Zoll: Well, Sallie Mae's "How America Pays for College" study found that in the most recent academic year 30% of the ways families were paying for college came from grants and scholarships, much of that from schools themselves. Only 27% came from parental income and savings, 18% from student loans, 11% from student income and savings, and then some other smaller sources involved there. This, I believe, was the first year that grants and scholarships were largest single source. And if you look at the amount that families are paying overall, including loans, for a year of attending college, it's decreased from $24,000 three years ago to $21,000 the most recent year.

And if you look, in particular, at what parental income and savings is paying as a portion, that has dropped from about $8,700 to about $5,700 in that time frame. Many families understandably are reporting feeling economically pinched in their efforts to try to pay for college, and in fact, in the survey, 48% of families reported reducing their overall household spending in order to make ends meet with regard to paying for college.

We're seeing families continue to be squeezed in terms of affording college. At the same time, the schools themselves in some cases anyway seem to be stepping up and offering more scholarship and grant money. There have been many reports that especially, for example, less prestigious private colleges are really, in some cases, struggling to fill classrooms, and for people who maybe think that a school is out of their price range, you might be able to get a better financial-aid offer than you might be anticipating.

Benz: Not just need-based aid, but also checking whether any merit-based aid is available?

Zoll: Exactly. That's a real important point. Many people who maybe come from middle- or upper-income households might think there's no point even applying for financial aid, thinking they make too much money. But merit-based aid is actually becoming a key tool. It's almost like a recruiting tool for some private schools to bring in students from wealthier households, who can pay a larger percentage of their total enrollment costs than say a student from a household that would qualify for a need-based aid.

Don't hesitate to apply for a merit-based financial aid. You may just end up getting it after all.

Benz: Adam, great tips and a great roundup of all of these news items going on in the realm of college funding. This is such an important area for so many families. Thank you so much for being here.